some call it faith

October 17, 2008

laissez ain't so fair after all

Over
the past two weeks the Dow Jones Industrial Average has fallen to mid-80's levels: during the past two
decades there have been peaks and troughs and booms and busts in which money
was made by a few, but the Many (the 50% of all U.S. households that own
stocks, either directly or in a mutual fund or retirement plan) would
have been better off buying art, wine, raw materials, bonds, leaving their
money in Money Market accounts (even after accounting for inflation), or
stuffing shoe-boxes with bills, than investing in the stock of public
companies.

The
phenomenon is even more pronounced in the US where a the dollar, ravaged by deficits - the product of war, over-consumption and fossil fuel addiction - has devalued investments in US equities relative to those of our
competitors, and our relative wealth.

The
recent sell-off has been so virulent that it is tempting to wonder if stocks
are now cheap. It more probable that we are seeing a
fundamental reappraisal of the value and utility of equities, and that
stocks and stock markets will never regain their former place as the prime
enablers of capital.

Over
the past two decades public corporations have become empire-sized and their
executives became despots, less and less answerable to their shareholders. The
consequence of this lack of oversight is that much of the value that had
previously flowed to corporations balance sheets, has been transferred to a new
executive ruling class as “results based” compensation, or lassoed by financial
engineers as a reward for inventing sophisticated off-balance sheet financial
instruments that created the perception of profit and further enhanced
executive class compensation at the Many's expense.

The
reality is that the ordinary shareholder is now so far from the trough that
investing in stocks has, for the Many, become a mugs game. Certainly the
wealthy ran from owning ordinary shares (and funds invested in ordinary shares)
many years ago, choosing instead to invest in hedge-funds, or opportunistic Buffetian
purchases of preferred stocks with that further distance ordinary
shareholders from return on their investments.

From
their media exposure to greed orgies lat Enron, Computer Associates, Sunbeam,
WorldCom, Adelphia and Tyco, the Many knew that they were getting the crumbs,
but persevered because a 401k promised a better return than a Money Market fund
and seemed safe enough.

The
lesson learned is that there is nothing safe or free about a barely regulated
market except that the influencers of the market are free to take whatever
return they can justify to themselves. Lehman boss Dick Fuld snatched $485m in salary, bonuses and
options between 2000 and 2007. Last year Merrill Lynch chairman Stan
O'Neal retired after announcing losses of $8bn, grabbing $161m as he walked out the door. This year bankers at Wall Street's top 6 firms will (unless we protest loudly) receive
pay and bonuses worth more than $70bn,despite their starring role in the worst financial crisis since the Great Depression.

The
illusion of safety destroyed; and having seen their life savings decimated
(along with their hopes that their children and their children’s children will
live richer more prosperous lives than they) by events way beyond their
control, the Many are heading for the exits - shareholders took $43.5 billion
from stock funds last month and an additional $49.3 billion last week.
Severely bitten, and in spite of the occasional mammoth upside leap, they will
not easily come back.

The
irony of the economic meltdown is that the US government, having created a
trillion dollar Sovereign Triage Fund, is now scrambling to buy the very stocks
that the Many off-loaded: deliriously inverting the Sovereign Wealth model
where cash-rich developing nations such as Singapore and China purchase
(supposedly) high-quality global assets for the benefit of their citizens, and
creating ever greater jeopardy by nationalizing the market's failures in the
hope that this will save the whole.

The
socialization of risk can only work if it is accompanied by offsetting
regulation and socialization of reward; otherwise the unfortunate result will
be a Soviet-style model that benefits only government bureaucrats (Treasury Secretary, Henry
Paulson’s swapping two years of service for a $200 Million tax break on selling his Goldman stock being a
particularly egregious leap in the wrong direction). Essential steps to a fair
and efficient market are:

Limiting
executive compensation to X [say the salary of the President] plus a percentage of annual profits

Restricting
public companies to one class of stock

Setting
statutory debt/capital ratios that apply beyond banking and finance to every
public enterprise

Finite limits on investment fund leverage [to prevent deleveraging disasters such as the one we are experiencing now]

Restricting the marketing or sale of any debt or equity instrument for which there is no
established exchange or market [designed to foster liquidity and the
development of new markets rather than discourage innovation]

Taxing
retained wealth through higher taxes on property, dividends etc., to
offset the inequitable distribution of the past two decades

Securities regulation and oversight of all major financial institutions by a Global Authority [simply recognizing the reality that finance is now and forever more a globally interconnected business].

Even
then, investment in stocks and stock markets will never be predictable or safe
and the Many should be discouraged from placing their retirement and life
savings in the markets directly. They should instead be offered government debt promising a predictable return

This will inevitably
lead to a smaller public equity sector and an enormous pool of state capital
(the sum total of our retirement and savings), that must then be invested by the best asset managers almost infinite money can buy, in industries of strategic importance to the Many
(infrastructure, sustainable energy, healthcare, and food production);
investments without which we will surely lose our prosperity and our beneficial
place in the world